Citizens Savings Bank, F.S.B. American Home Funding, Inc. v. Verex Assurance, Inc. v. Arthur Pearce L. David Strickland Mariner's Cay Development Corporation Robert G. Irick John H. Disher, III Disher, Hamrick & Myers Franklin E. Robson, Third Party (Two Cases). Citizens Savings Bank, F.S.B. American Home Funding, Inc. v. Verex Assurance, Inc. v. Arthur Pearce L. David Strickland Mariner's Cay Development Corporation Robert G. Irick John H. Disher, III Disher, Hamrick & Myers Franklin E. Robson, Third Party

Citations: 883 F.2d 299; 1989 U.S. App. LEXIS 12490Docket: 88-2554

Court: Court of Appeals for the Third Circuit; August 23, 1989; Federal Appellate Court

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Citizens Savings Bank and American Home Funding, Inc. (collectively "Lenders") appeal four district court rulings following an adverse jury verdict concerning private mortgage insurance (PMI) for loans related to the Mariner's Cay condominium development. The Lenders contest the jury instruction on fraud elements, the denial of a directed verdict on agency, the instruction regarding imputation of knowledge from agent to principal, and the exclusion of a revised 1985 Master Policy. Verex Assurance, Inc., the defendant, cross-appeals the refusal to instruct the jury that pervasive fraud could justify rescission of private mortgage insurance without needing findings for each unit. The Court of Appeals affirms the district court's rulings, finding no error.

The case centers on PMI that protects lenders against borrower defaults on loans for condominium purchases financed by Citizens and AHF. The Mariner's Cay units were sold primarily through AHF financing, which required a minimum 10% down payment. The Seller recommended using Franklin Robson as the closing attorney, although the Lenders claimed buyers could choose their own attorney. Testimony indicated some buyers felt pressured to use Robson. AHF provided detailed closing instructions to Robson, including requirements for premium payment authorization and completion of necessary affidavits.

Prior to loan closings, the Lenders submitted a "Commitment to Insure" request to Verex, detailing the terms of the sale and loan, confirming the down payment, and stipulating that Verex's insurance would only cover loans as per the Commitment. Verex subsequently issued a Certificate of Insurance to the Lenders, which was re-submitted post-closing.

Final loans were not aligned with the original Commitments, as purchasers received cash kickbacks from the Seller, facilitating a 100 percent financing scheme. These kickbacks were pre-arranged agreements where down payments were refunded at closing, enabling false statements regarding inflated sales prices. Robson facilitated the kickbacks under Seller's and purchasers' direction, collecting checks that were deposited in an escrow account and later disbursing rebates to purchasers. Initially, these transactions occurred through Robson's personal escrow account before a second account was established after multiple closings.

In August 1982, AHF discovered irregularities, including the use of white-out on appraisals and HUD-1 Settlement Statements, which referenced questionable payoffs for furniture and deposit refunds. An audit by Art Pearce revealed some units were sold furnished or leased back, and references to 'payoff to Linker' were explained as rebates for furniture purchases, a practice confirmed by other developments. Pearce noted concerns about unit pricing, Robson's independence, and the legitimacy of PMI, advising against including furniture costs in real estate transactions.

When Verex learned of the kickback scheme, it sought to rescind 52 Certificates, leading the Lenders to file a federal lawsuit for wrongful rescission. Verex countered, claiming the Certificates were invalid due to misrepresentations by the Lenders' agents. Post-trial, the jury allowed Verex to rescind 34 Certificates but upheld 18 as valid. The jury's finding of fraud necessitated punitive damages under South Carolina law, resulting in an award of $1.00 to Verex.

In South Carolina, the determination of an agency relationship is a factual issue for the jury when there are facts suggesting such a relationship. In this case, the primary issue was whether Robson acted as an agent for the Lenders. The Lenders argued that the district court should have resolved this matter as a legal question based on their original instructions to Robson. However, Verex provided additional evidence, indicating that purchasers could not select their closing attorneys other than Robson and that Pearce had specific interactions with Robson regarding closing procedures. Pearce also directed Robson on document handling, suggesting that the Lenders had control over Robson's actions.

While Robson's fee was paid by the Purchaser, this alone suggested an agency relationship favoring the Purchaser under South Carolina law. However, other evidence indicated Robson might be the agent of the Lenders. The record contained sufficient evidence for the jury to conclude that Robson was indeed acting as the Lenders' agent, making them liable for his fraudulent actions, even if they did not have actual knowledge of his misdeeds. 

The jury's decision was deemed fair, emphasizing that both Robson and the Lenders contributed to the fraudulent scheme, and as a result, the burden of loss should not fall on Verex. Legal precedents establish that when two innocent parties are affected by a third party's wrongful act, the one more at fault must bear the loss. This principle was supported by the case of McFaddin, where a closing attorney's fraud led to the lender being held responsible due to the trust placed in the attorney. The ruling underscored the notion that the lender’s placement of the attorney in a position to commit fraud resulted in liability for the loss incurred.

The Lenders had a close relationship with Robson, who was linked to the developers, and provided him with detailed closing instructions. In September 1982, Art Pearce reviewed Robson's records for irregularities in loan closings. Although the situation was regrettable, the jury determined that the Lenders, having enabled Robson's fraud, must bear the loss. 

Both parties contested the district court's jury instructions. The Lenders challenged the court's fraud elements charge, which included nine elements, compared to their proposed five. Since the court's charge encompassed all five elements from the Lenders' version, any error was deemed harmless. 

Regarding evidence standards, the court cited Gilbert v. Mid-South Machinery Co., affirming that fraud must be established by a preponderance of the evidence, which can also be clear and convincing. The court's charge was found appropriate as it adhered to this standard.

Verex contended that pervasive fraud warranted rescission of all private mortgage insurance (PMI) linked to a development, eliminating the need for individual fraud findings. The court rejected this argument, stating that each PMI certificate represented a distinct transaction necessitating separate proof. The jury was tasked with determining the fraud's impact on each unit's PMI, and the court upheld its instructions.

Lastly, the court excluded evidence of a 1985 revision to Verex's Master Policy, deeming it irrelevant and potentially confusing for the jury. This decision was upheld as within the district court's discretion. The judgment was affirmed.